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Hello. Welcome. My name is Clay Erwin. Thank you very much for choosing to share part of your day with us. Together, I'm joined by Grace Peters and Steve Parker, and together we represent the global investment strategy team.
And over the course of the next 30 minutes, we aim to share with you our outlook for 2026, promise and pressure. Here within this document, we share our expectation for capital market returns over the course of 2026. But we also examine the tension that exists between macro forces and capital market returns.
Now, as we do this, it's important to consider the background in which we find ourselves today. Here we are in the twilight of 2025, finishing a year that we characterized as comfortably uncomfortable. And here we experienced a year in which there were shifting geopolitical forces but also equity markets, which reached all-time highs, a declining dollar, and lower interest rates as well.
And our expectation is for 2026 to be quite similar in an environment of shifting macro forces but still record equity levels, a stable dollar, lower interest rates, but persistent inflation. Now, with that is a backdrop, we need to consider how it is that we are going to get there. And within our outlook, we examine three primary forces or megatrends that we think will characterize much of 2026, specifically artificial intelligence, global fragmentation, and persistent inflation.
So, Steve, I'd like to bring you into the conversation. Steve Parker, our Co-Head of Global Investment Strategy. Artificial intelligence is part of all conversations. It feels almost ubiquitous. So as we think about artificial intelligence, both in 2025 and 2026, it has had a tangible and real impact on our daily lives. Would you help us understand the impact that it has had on the capital markets?
Yeah, Clay, it's hard to overstate what sort of impact that it has had. If you look back to the launch of ChatGPT in 2022, 75% of the gains, 80% of the earnings, and 90% of the capital spending growth of the S&P has been driven by AI-related companies.
If you think about the capital spending and the impact on the economy in the US, in the first half of this year, AI-related spend contributed more to growth than the consumer. I'd argue, you can't have a view on markets without having a view on AI.
All right. So, before we talk more about AI itself, let's talk about some of those numbers. I was shocked the first time that you shared them with me. 80% of the profits. 90% of the spending. How concerned are you that there might be a bubble in the space? And I remind you, a bubble could come from a lot of things. It might be overspending. It could be overleverage, or perhaps just prices that are too high. Perhaps we start with the first one first.
You talked about AI being ubiquitous. I'd say that bubble concerns around AI are also rather ubiquitous. When we think about the path forward for new technology and transformative things like AI, I think it's important to have a framework and to ask ourselves those key questions, and also to look back on history at previous bubbles to help us understand what are the key things that we should be watching.
The first one that you mentioned is overcapacity and the amount of spending. You see new headlines about data centers each and every day. And this is where I think looking back to the bubble is particularly informative.
In the late '90s, there was nearly 40 million miles of fiber that was installed to support the internet. And by mid-2001, about 1% of that was actually being used. It was supply in search of demand. The AI story couldn't be more different. If you look at data center vacancy rates, it's at historic lows, 1 and 1/2%. And for all of the headlines about new construction, 3/4 of the capacity from that new construction is already preleased.
Well, that is materially different. In the year 2000, we did see a tremendous amount of overbuild in anticipation of demand. And we actually see now is the opposite, that we are building and still unable to meet what feels like an insatiable appetite for power, for processing.
Let's talk a little bit about leverage then. What we've seen in recent years is the majority of spend within the art of the artificial intelligence ecosystem has been funded from free cash flow. But now we're actually starting to see some of the market participants issuing debt and debt financing some of these investments. Does that cause concern?
If we think about this bubble framework as a traffic light, if you will, this leverage question is something that's probably starting to flash yellow. As you said, most of the spend up to this point has been funded from earnings and free cash flow from the hyperscalers, who have had tremendous amounts of success and earnings growth. That reduces the risk related to the story.
Recently, the next phase of growth is looking to be increasingly financed by debt, as well as free cash flow and equity. That's something that we need to keep an eye on. But when you look at credit spreads, when you look at the cash flow generation that's still coming from these companies, it's not something that makes us overly concerned at this point.
Well, let's talk a little bit about some of the circularity that we've seen in this investment. There's some cases where you see providers of the AI value chain providing capital as well to the consumers of their product. Does that cause concern?
Yeah, it certainly increases the connectivity of the AI ecosystem. So as you're explaining, what does this mean? Chipmakers, rather than just selling to their customers now, are also financing them or even investing in them.
And I'd say in the short term, this is actually probably a positive. It reinforces the momentum around this build out, supports the continued growth. But as I said, it also increases that connectivity. So inevitably, when we do hit that bump in the road, it means that you should probably expect more volatility from a more connected environment.
You said at the onset that 80% of the equity market returns have been derived in part from artificial intelligence. When you think about the equity market returns, when you think about the prices that you have to pay for these companies now, basically the valuation story, how do you marry the opportunity set with what feels like the elevated valuations of today?
Yeah, I think when you look at valuations, we're seeing more excitement than euphoria. And this is another area where this seems very different from the internet bubble. First and foremost, the absolute level of PE multiples on these AI-related names, while high, are certainly nowhere near the exuberance that we saw in the late '90s.
The other important dynamic that I think is really important is that while these companies have seen tremendous gains in their stock prices, multiples have actually come down in recent years. And that's because earnings growth has surpassed even that capital appreciation. We think that these multiples are justified as long as that growth trajectory can continue. And we're confident that will be the case.
So we spent a lot of time talking about the capital markets. Let's talk a little bit about real life. Let's talk about Main Street. One of the other concerns, if you will, is the disruption to the labor force. I'm sure that there are many people on the call today that have kids that are either entering or are about to enter the labor force. And there are these concerns about, what is the job market going to look like tomorrow? And how different will it be from the previous decade?
Yeah, I think the job market is going to adapt. And the labor force of the future is going to look different from the labor force of today. We think this is likely to happen in two phases, initially with a lot of the focus on automation, greater productivity. Certainly there are going to be industries like customer support, like coding, that are likely to be under pressure.
But at the same time, you have this critical infrastructure, whether it's related to power or cybersecurity, where new jobs are going to be created right away. Longer term, the next phase of this is about growth and imagining the unimaginable.
When you think we were talking earlier about the internet boom and the fact that when we were first looking at this bubble, nobody could have anticipated that today there would be 67 million content creators taking advantage of the internet. And that doesn't even include our own social influencer, financial influencer, Grace Peters, over here.
Let's not bring Grace in quite yet. So, in summary, you recognize that the trend that we've enjoyed for the last couple of years is likely going to continue. Now, ultimately, what that means in terms of capital market returns, what that means for the labor market is something that we're still going to have to wait and see how it plays out.
l Investment Strategy based in London, thank you very much for joining us today. Thrilled to have you. You've spent a lot of time matching investment opportunities with this mega trend. So when you think about how to best capture or participate in some of this growth, where do you start the conversation?
Yeah, so-- I mean, we have to say that we're in a new phase of AI here. We're at the phase where adoption is ramping up. I think the technology is proven. And when that comes to the investment opportunities, we really like to invest across public and private markets, public markets because that's often where the strong balance sheets, the cash flows that you guys have referenced already exist, and private markets because I think many of the AI opportunities, they aren't yet evident to us. They don't necessarily exist.
So we tend to employ a four-point approach. The first still does start with the hyperscalers. So we're talking about the large-cap tech players, the Amazon, Google, Meta, and Microsoft of the world. And that's because the market has consistently underestimated the CapEx that these hyperscalers need to invest to meet demand.
And by extension, the market has consistently underestimated the earnings growth. And we think that earnings growth can continue at around a pace of about 20% per year over the next couple of years. So the short to medium term, I think, still favors these hyperscalers to capture the benefit of cloud and AI infrastructure as well.
If I could get you to spend a second longer on that earnings growth conversation, Steve was talking about how the equity markets are likely to continue to trade up over the course of the year, and that he's not concerned about valuations. Is it because of this disproportionately high rate of earnings growth?
For sure this is a part of it. I mean, this collection of companies, the large cap technology names have driven earnings so far, while the rest of the market has been more stagnant when it comes to year-over-year earnings growth.
And whilst we do see a broadening theme in the year ahead, I think that the technology companies are still going to deliver that double-digit earnings growth that will power the market, power, the US equity
Market. So an allocation to AI, I think, does start there, but it doesn't end there, because the next theme to us really is power. Because to power the data center build-out and to power increasing GPT usage, if we think about power of ChatGPT-5 versus version 3, you're already using a two and a half-fold increase in power. And this is really weighing on a system where power infrastructure is already old.
And so power to US is the next leg of the theme. And what's really interesting when it comes to the positions that you take in the equity market in order to invest in the power value chain is that it's a very different exposure.
You're then looking at utilities, which actually trade at around a 15% discount to the S&P, and therefore you're starting to get more attractive valuations. You'd look at industrials as well as part of that value chain. So, then you're actually adding really nice complementary exposures that are still geared into AI and the development of AI but in a more diversified way.
It's unique. It feels almost ironic that one of the better ways of investing in this cutting-edge technology in the world of tomorrow is in something as basic as utilities.
For sure. But I think that that's the appeal of the sector, really, that it's a sector that hasn't delivered much growth but now I think is poised for a step change in top line and earnings growth and with a valuation opportunity as well.
So that would be my second way of investing. The third is then to go back to the opening words that I say, that we're entering this new phase of AI where we're seeing increasing adoption. At least 10% of the US economy is using AI day to day to generate goods and services. And actually, that number could be even higher.
So now we're seeing AI propagate across all sectors. And within that, there will be companies that can deploy the technology, not just for efficiency. But the really interesting thing will be to observe the companies that are using it to generate incremental revenues and to sustainably grow market share, whatever sector they sit in. So that would be my third bucket.
And what tells me that this is not yet priced is the fact that there is still a really strong dialogue around corporate margins and a big fear that margins will pull back from what have been levels--
Because they've been elevated.
Because they've been elevated. They've climbed. But I actually think that because of this adoption of AI, corporate margins could be more resilient across the board. But that healthy debate is part of what tells me that this part, this third leg, is not yet priced.
I've observed over the last several years that shareholders have been very tolerant of management companies deploying capital into artificial intelligence. Do you think that in 2026, we will see more shareholder demand for descriptions of what the return on those investments have been?
I think no doubt. I mean, look, the large-cap technology companies, their business model is shifting. They're moving from capital light to capital intensive. And companies across the board, I think, are in this phase now where there is real FOMO, Fear of Missing Out, because you don't want to be the number two, number three, number four. You do want that first-mover advantage.
But I think coming with that, there obviously will be accountability for technology players but players across the board, because otherwise, that capital could have gone to share buybacks or dividend growth i.e. shareholder returns.
But for now, for this part of the J-curve, it makes sense to invest. And I think they would be the first three pillars. The fourth would be in private markets. Private markets, we know that companies are staying private for much longer. And that is particularly the case in the technology sector.
So now you're seeing an average tech company would stay private for 14 years. That used to be eight years. And when you look at the 10 largest players in private markets technology, they're worth $1.5 trillion. So there's a huge amount of opportunity there.
There's also risk because there's a lot of cash, dry powder, flying around. So as always in private markets, you do need to be selective. But I would definitely have an inclusion of private when it comes to accessing AI.
So let's broaden the conversation out a little bit beyond just specific to artificial intelligence but the impact that it might be having on equities around the world. So when you think about equity returns in 2026, we've already mentioned potential double-digit returns, the potential for double-digit earnings growth. How much of this is attributed to this megatrend of artificial intelligence?
A decent amount. I've mentioned 20% earnings growth, we think, out of the US large-cap tech players for the year ahead. But I think there is this broadening theme with some of these other sectors. I mean, there's five sectors of the S&P that we like. I've mentioned some of them in technology, utilities, and industrials, but also financials and parts of the health care market.
And so all together, I think that you could be moving from a period driven primarily by tech, where S&P earnings that historically have been around 7% per annum could be more like high single-digit to low double-digit returns, which would be a new era of growth for the equity market and, most importantly, would compensate for some of the valuation.
Said differently, you could still see equity market valuations fall and equities rise 7% to 10% per annum because of the underlying earnings dynamics. So our price target for the S&P specifically over the next 12 months is 7,300. That's just shy of a double-digit return. And it's a similar return around the world actually in the developed market. So yeah, positive outcome.
It's important that we point out how unique that is. This would be the fourth year of double-digit growth for the equity markets, which is certainly something that we don't see very often now. If we are right in that expectation of continued economic activity, which is positive around trend growth, we get positive equity market returns as well, does that bode well for the credit markets?
It does. I mean, many of the dynamics are the same. And broadly, we are talking about large-cap equities here because of the strong underlying balance sheet that they have. But I think all of this, whether it be an equity or credit markets, we're constructive there. We think that the yields are attractive. But all of this is indicative of the fact that I think you are seeing increasingly economic value flow to capital rather than labor, which is good ultimately for owners of risk assets.
Excellent. All right. So, I sense your optimism for the capital markets as well as the economy. Our title of our outlook this year is promise and pressure. I suppose it is this optimism that is the promise component.
Now let's spend a second on the pressure, namely the idea of global fragmentation. I'd be curious to hear what is it that you mean when you talk about fragmentation. Is this just a continuation of some of the trends that we've seen in previous years, or is this something different altogether?
No, I think there's a real sense of change that's coming about at the moment with countries really looking inward. And this really means that they are prioritizing self-sufficiency, security. And there are many issues around national security that I think are in focus, from trade to immigration to energy security, supply chain, and critical components and minerals as well.
And whilst there's certainly been catalysts that have played out through 2025, I don't think it is a brand new theme. I think, actually, you can go back to my previous comment about how increasingly you've seen economic benefit flow to labor-- to capital rather than labor, which has caused some disenfranchisement amongst voting populations that we've seen play out over a number of years. Of course, the COVID pandemic caused supply chain vulnerabilities to come to the fore.
So, security overall is another huge theme for us along with artificial intelligence. And it's not just, again, a US theme from 2025. This is undoubtedly global because the theme of economic nationalism is also prompting a strong fiscal response.
And so when you look to areas like Germany, very strong government direction of capital with the infrastructure bill and defense spending. And this, I think, is going to see, as an example, German GDP be pretty close to US GDP by the time you get to 2027.
That is remarkable. And it does feel like it is permeating beyond just national area but also at the corporate level. JP Morgan, for example, has just launched our trillion and a half dollar security and resiliency investment plan. And so you're seeing it take place in multiple levels. Now, what does that mean from an investment opportunity when you think about security and the investment in security around the world?
I think there's two things. The first thing is the spread of growth. So as governments are playing a firmer hand in the economy and corporates can obviously follow suit and potentially benefit from that, you're seeing growth being spread more evenly around the world. And the example I'd give was, as an example, US and Germany.
The second thing is, again, when you think about the investment opportunities, this speaks to industrials, infrastructure, and real assets. So again, you're seeking out, from fragmentation opportunities, new opportunities of growth where the value, the economic value, is going to accrue to the shareholder. So--
Now, we've seen some of this fragmentation already play out. And when you think about the year that is ending now, this is a year characterized by the flight from the dollar. You've seen the dollar decline. There was concerns about treasuries. And so when you think about what is taking place today, is that a trend that you think will continue as well in terms of dollar decline?
Yes. I mean, the dollar really has been the vehicle through which the market has priced a lot of this fragmentation risk, and even deeper than that, concerns over deficits, over trust in the institution. And that obviously is what's led to what, for many of our euro and sterling-based investors, has been quite a painful leg down in the dollar through the course of this year.
Obviously, elements of that are going to continue. I think that the big overvaluation of the dollar has already played out. The worst is behind us. There could be, over the medium term, still a drip lower in the dollar.
But I think if we look to just 2026 and the cyclical backdrop that we see-- and you alluded to this clay in your walk-up to some extent-- we've got growth that we think in the US is actually going to re-accelerate in the first half of the year. You've got inflation that could stay warm and a Fed that whilst it's cutting, may not cut quite as much as the market thinks that would support interest rate differentials in the favor of the US.
So our thought is more cyclically that the dollar is going to be in a period of consolidation now. But the longer-term themes that we're talking about in this chapter of the outlook, I think, still are in play and still does very much prompt, say, a flight to gold, where I still think there's more upside and, indeed, the diversification angle.
I want to hear more about gold. But let's wait for a moment. The last several years, as the world globalized and as the supply chains became more linear, you saw many market participants simply invested in the United States because you could benefit from growth taking place all around the world by investing in the United States.
Do you think that next year, we will have to be more diversified internationally because of some of this inward move that you've described? To participate in the growth in Germany, will you have to make investments locally? Or do you think you could still do that via supranationals?
I think that the multinationals in each region, I think, are still a really sound place to go because typically, they have the quality balance sheets that we seek and that we spoke about before. But I do think that it's going to be a really sound philosophy to be far more intentional about how you diversify.
A lot of this, again, speaks to clients that have got different funding needs, different currency needs, that I think that the geographic diversification piece is going to be even more important. And we've mentioned Europe a few times. But there are equally very sound opportunities when we look to emerging markets that are emerging from a decade of underperformance.
And even in areas like China, when we think about how their economy is changing, China is going to see more revenues out of technology than it is out of property and construction combined. So some really quite fundamental changes that are arising from governments directing capital and economies responding.
Excellent. So this idea of fragmentation, should it continue, is likely something that will compel us to think differently about the way that we construct portfolios in 2026 and beyond.
Let's talk a moment about inflation, the third of our megatrends. This is also something that might compel us to think differently about the way that we construct portfolios. Steve, it was only a couple of years ago that you couldn't find inflation anywhere throughout the developed world. Now, postpandemic, that experience has been a little different. Talk to us about that evolution of inflation and why it is the concern that it represents in portfolios today.
Yeah, I think a lot of the trends that we've been talking about, whether it's increasing fragmentation, greater fiscal spending, some of these imbalances in markets, the reversal of the globalization trends that was all about efficiency, mean that we're probably in an environment where the floor on inflation is higher and the volatility of inflation is going to be greater.
Now, that has a meaningful impact in the way that we think about portfolios. Because traditionally, in a world where inflation wasn't a concern, a traditional stock-bond portfolio could do a lot of the heavy lifting. You could allocate to stocks for growth. You could allocate to bonds for income and diversification.
But as we've seen over the last couple of years, in a world where inflation becomes a bigger risk, then perhaps bonds aren't going to be able to play that same role in diversifying your portfolio.
Now, talk to me about the level of inflation. So in this moment postpandemic, it reached almost 8%. This was while a lot of market participants thought that inflation would only be transitory. And it has proven to be anything but. Right now, current level of inflation, and what is the expectation for 2026?
Yeah, we think inflation is going to move from-- right now it's in that 2 and 1/2% to 3% range. We think it gradually begins to come down. Our view for 2026 is 2 and 1/4% to 2 and 1/2% here in the US, probably a little bit higher in the front end of the year, a little bit lower in the back half of the year as some of the tariff impacts begin to wane.
Now, one of the things to remember, we often think about inflation. And we think about the risks associated with inflation. Inflation, if it's stable, if it's not too high, is actually a good thing. It contributes to pricing power. It contributes to nominal economic growth, and it contributes to earnings.
And so when you think about that 2 and 1/4% to 2 and 1/2% range we're looking for next year, it's a sweet spot because it supports that growth. But it also gives the Fed cover to continue easing. And we think we're going to see two more cuts in the next year.
So many have characterized inflation as the great confiscation of wealth. As you point out, that's not necessarily the case. But just the same, as you think about building portfolios in 2026, as you think about opportunities which might protect you from some of the impacts of rising prices, where do you begin the conversation?
Yeah, if inflation is the bigger concern, then we think you need to change the playbook a little bit in the way you think about diversifying your portfolio. Specifically, you want to look to things like real assets, gold, and infrastructure as potential ways to hedge against some of those inflation risks.
And importantly, these conversations that we're having now are not just tactical views about the next 6 to 12 months, but rather more strategic conversations in a world where we think inflation will be structurally higher.
Grace, we'd like to talk about other alternatives within the portfolio. You've spent a lot of time talking about gold. You've mentioned it a couple of times in this call as well. Do you think that will continue to represent an important part of it?
I do, Clay. I mean, it's hard to believe, isn't it? After a 50% rally this year that followed already an up year in the prior year, we're looking for another 30% on gold. So that'll take us to around $5,200.
And why is that? Feeding into a lot of the things that Steve said, what's missing from the portfolio if you just have the stock-bond starting point, which is a great starting point but, I think, can be enhanced.
We are looking to lean into uncorrelated returns, or at least less correlated returns, and hedges for many of the issues we've discussed for elevated deficits, for mistrust in the institution, including the Federal Reserve.
And I think gold really satisfies that request, not just for many of our clients, but actually for many of the central banks and significant institutional allocators of capital. So we've seen some of that play out already. That's obviously what's driven the gold price higher. And the supply of gold is so tight that small changes in demand can drive it quite meaningfully.
But consider that when we look around all of the EM central banks, 16 of them still have below a 10% holding in gold. China is now up to 9%. And that compares and contrasts with a European central bank. That would be at 15% to 20%. So whether it be central banks, institutions, or of private clients via an ETF, I think gold can still move considerably higher.
That's interesting because this is not out of concern that you're describing this rally. This feels almost more structural and independent of some of the market moves.
Yes, I think that's absolutely right. And it's a natural way to think. Whilst I like the US equity and economic story, if there's a lot of dollars already in a portfolio, what's a natural thing to bring in to increase diversification? It's gold.
But it doesn't stop there. I think there's other things. We've mentioned infrastructure as well. But I'd also consider hedge funds, and specifically macro and relative value hedge funds. And I think, again, this is a great sort of simple step to enhance the overall portfolio volatility and correlation benefits.
So whether you call them alternative investments, nontraditional investments, it feels like this is the area in which we're looking to expand the toolkit within a portfolio, perhaps real assets, commodities, noncorrelated hedge funds, infrastructure investments. It certainly is a bit of a change in the way that one would build a core and diversified portfolio.
So with that, let's wrap. We expect a year of promise and pressure in 2026, one characterized by positive economic growth, higher equity markets, lower interest rates, and perhaps higher in volatile inflation.
I remind you that the most important strategy when it comes to investing is to have an investment strategy. Please reach out to your JP Morgan advisor and make sure that you have a long-term plan designed to help you achieve the goals that you have for your wealth. Thank you for spending part of your day with us.
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A signature written in gold ink reads, J.P. Morgan.
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Text, Clay Erwin, Global Head of Investment Sales and Trading.
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Hello. Welcome. My name is Clay Erwin. Thank you very much for choosing to share part of your day with us. Together, I'm joined by Grace Peters and Steve Parker, and together we represent the global investment strategy team.
And over the course of the next 30 minutes, we aim to share with you our outlook for 2026, promise and pressure. Here within this document, we share our expectation for capital market returns over the course of 2026. But we also examine the tension that exists between macro forces and capital market returns.
Now, as we do this, it's important to consider the background in which we find ourselves today. Here we are in the twilight of 2025, finishing a year that we characterized as comfortably uncomfortable. And here we experienced a year in which there were shifting geopolitical forces but also equity markets, which reached all-time highs, a declining dollar, and lower interest rates as well.
And our expectation is for 2026 to be quite similar in an environment of shifting macro forces but still record equity levels, a stable dollar, lower interest rates, but persistent inflation. Now, with that is a backdrop, we need to consider how it is that we are going to get there.
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Text, Outlook 2026: Promise and Pressure. Position for the AI revolution. Think fragmentation, not globalization. Prepare for inflation’s structural shift.
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And within our outlook, we examine three primary forces or megatrends that we think will characterize much of 2026, specifically artificial intelligence, global fragmentation, and persistent inflation.
So, Steve, I'd like to bring you into the conversation. Steve Parker, our Co-Head of Global Investment Strategy. Artificial intelligence is part of all conversations. It feels almost ubiquitous. So as we think about artificial intelligence, both in 2025 and 2026, it has had a tangible and real impact on our daily lives. Would you help us understand the impact that it has had on the capital markets?
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Text, Stephen Parker, Co-Head of Global Investment Strategy. 1. Position for the AI Revolution.
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Yeah, Clay, it's hard to overstate what sort of impact that it has had. If you look back to the launch of ChatGPT in 2022, 75% of the gains, 80% of the earnings, and 90% of the capital spending growth of the S&P has been driven by AI-related companies.
If you think about the capital spending and the impact on the economy in the US, in the first half of this year, AI-related spend contributed more to growth than the consumer. I'd argue, you can't have a view on markets without having a view on AI.
All right. So, before we talk more about AI itself, let's talk about some of those numbers. I was shocked the first time that you shared them with me. 80% of the profits. 90% of the spending. How concerned are you that there might be a bubble in the space? And I remind you, a bubble could come from a lot of things. It might be overspending. It could be overleverage, or perhaps just prices that are too high. Perhaps we start with the first one first.
You talked about AI being ubiquitous. I'd say that bubble concerns around AI are also rather ubiquitous. When we think about the path forward for new technology and transformative things like AI, I think it's important to have a framework and to ask ourselves those key questions, and also to look back on history at previous bubbles to help us understand what are the key things that we should be watching.
The first one that you mentioned is overcapacity and the amount of spending. You see new headlines about data centers each and every day. And this is where I think looking back to the bubble is particularly informative.
In the late '90s, there was nearly 40 million miles of fiber that was installed to support the internet. And by mid-2001, about 1% of that was actually being used. It was supply in search of demand. The AI story couldn't be more different. If you look at data center vacancy rates, it's at historic lows, 1 and 1/2%. And for all of the headlines about new construction, 3/4 of the capacity from that new construction is already preleased.
Well, that is materially different. In the year 2000, we did see a tremendous amount of overbuild in anticipation of demand. And we actually see now is the opposite, that we are building and still unable to meet what feels like an insatiable appetite for power, for processing.
Let's talk a little bit about leverage then. What we've seen in recent years is the majority of spend within the art of the artificial intelligence ecosystem has been funded from free cash flow. But now we're actually starting to see some of the market participants issuing debt and debt financing some of these investments. Does that cause concern?
If we think about this bubble framework as a traffic light, if you will, this leverage question is something that's probably starting to flash yellow. As you said, most of the spend up to this point has been funded from earnings and free cash flow from the hyperscalers, who have had tremendous amounts of success and earnings growth. That reduces the risk related to the story.
Recently, the next phase of growth is looking to be increasingly financed by debt, as well as free cash flow and equity. That's something that we need to keep an eye on. But when you look at credit spreads, when you look at the cash flow generation that's still coming from these companies, it's not something that makes us overly concerned at this point.
Well, let's talk a little bit about some of the circularity that we've seen in this investment. There's some cases where you see providers of the AI value chain providing capital as well to the consumers of their product. Does that cause concern?
Yeah, it certainly increases the connectivity of the AI ecosystem. So as you're explaining, what does this mean? Chipmakers, rather than just selling to their customers now, are also financing them or even investing in them.
And I'd say in the short term, this is actually probably a positive. It reinforces the momentum around this build out, supports the continued growth. But as I said, it also increases that connectivity. So inevitably, when we do hit that bump in the road, it means that you should probably expect more volatility from a more connected environment.
You said at the onset that 80% of the equity market returns have been derived in part from artificial intelligence. When you think about the equity market returns, when you think about the prices that you have to pay for these companies now, basically the valuation story, how do you marry the opportunity set with what feels like the elevated valuations of today?
Yeah, I think when you look at valuations, we're seeing more excitement than euphoria. And this is another area where this seems very different from the internet bubble. First and foremost, the absolute level of PE multiples on these AI-related names, while high, are certainly nowhere near the exuberance that we saw in the late '90s.
The other important dynamic that I think is really important is that while these companies have seen tremendous gains in their stock prices, multiples have actually come down in recent years. And that's because earnings growth has surpassed even that capital appreciation. We think that these multiples are justified as long as that growth trajectory can continue. And we're confident that will be the case.
So we spent a lot of time talking about the capital markets. Let's talk a little bit about real life. Let's talk about Main Street. One of the other concerns, if you will, is the disruption to the labor force. I'm sure that there are many people on the call today that have kids that are either entering or are about to enter the labor force. And there are these concerns about, what is the job market going to look like tomorrow? And how different will it be from the previous decade?
Yeah, I think the job market is going to adapt. And the labor force of the future is going to look different from the labor force of today. We think this is likely to happen in two phases, initially with a lot of the focus on automation, greater productivity. Certainly there are going to be industries like customer support, like coding, that are likely to be under pressure.
But at the same time, you have this critical infrastructure, whether it's related to power or cybersecurity, where new jobs are going to be created right away. Longer term, the next phase of this is about growth and imagining the unimaginable.
When you think we were talking earlier about the internet boom and the fact that when we were first looking at this bubble, nobody could have anticipated that today there would be 67 million content creators taking advantage of the internet. And that doesn't even include our own social influencer, financial influencer, Grace Peters, over here.
Let's not bring Grace in quite yet. So, in summary, you recognize that the trend that we've enjoyed for the last couple of years is likely going to continue. Now, ultimately, what that means in terms of capital market returns, what that means for the labor market is something that we're still going to have to wait and see how it plays out.
Grace Peters, our Co-Head of Global Investment Strategy based in London, thank you very much for joining us today. Thrilled to have you. You've spent a lot of time matching investment opportunities with this mega trend. So when you think about how to best capture or participate in some of this growth, where do you start the conversation?
Yeah,
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Text, Grace Peters, Co-Head of Global Investment Strategy.
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so-- I mean, we have to say that we're in a new phase of AI here. We're at the phase where adoption is ramping up. I think the technology is proven. And when that comes to the investment opportunities, we really like to invest across public and private markets, public markets because that's often where the strong balance sheets, the cash flows that you guys have referenced already exist, and private markets because I think many of the AI opportunities, they aren't yet evident to us. They don't necessarily exist.
So we tend to employ a four-point approach. The first still does start with the hyperscalers. So we're talking about the large-cap tech players, the Amazon, Google, Meta, and Microsoft of the world. And that's because the market has consistently underestimated the CapEx that these hyperscalers need to invest to meet demand.
And by extension, the market has consistently underestimated the earnings growth. And we think that earnings growth can continue at around a pace of about 20% per year over the next couple of years. So the short to medium term, I think, still favors these hyperscalers to capture the benefit of cloud and AI infrastructure as well.
If I could get you to spend a second longer on that earnings growth conversation, Steve was talking about how the equity markets are likely to continue to trade up over the course of the year, and that he's not concerned about valuations. Is it because of this disproportionately high rate of earnings growth?
For sure this is a part of it. I mean, this collection of companies, the large cap technology names have driven earnings so far, while the rest of the market has been more stagnant when it comes to year-over-year earnings growth.
And whilst we do see a broadening theme in the year ahead, I think that the technology companies are still going to deliver that double-digit earnings growth that will power the market, power, the US equity Market. So an allocation to AI, I think, does start there, but it doesn't end there, because the next theme to us really is power. Because to power the data center build-out and to power increasing GPT usage, if we think about power of ChatGPT-5 versus version 3, you're already using a two and a half-fold increase in power. And this is really weighing on a system where power infrastructure is already old.
And so power to US is the next leg of the theme. And what's really interesting when it comes to the positions that you take in the equity market in order to invest in the power value chain is that it's a very different exposure.
You're then looking at utilities, which actually trade at around a 15% discount to the S&P, and therefore you're starting to get more attractive valuations. You'd look at industrials as well as part of that value chain. So, then you're actually adding really nice complementary exposures that are still geared into AI and the development of AI but in a more diversified way.
It's unique. It feels almost ironic that one of the better ways of investing in this cutting-edge technology in the world of tomorrow is in something as basic as utilities.
For sure. But I think that that's the appeal of the sector, really, that it's a sector that hasn't delivered much growth but now I think is poised for a step change in top line and earnings growth and with a valuation opportunity as well.
So that would be my second way of investing. The third is then to go back to the opening words that I say, that we're entering this new phase of AI where we're seeing increasing adoption. At least 10% of the US economy is using AI day to day to generate goods and services. And actually, that number could be even higher.
So now we're seeing AI propagate across all sectors. And within that, there will be companies that can deploy the technology, not just for efficiency. But the really interesting thing will be to observe the companies that are using it to generate incremental revenues and to sustainably grow market share, whatever sector they sit in. So that would be my third bucket.
And what tells me that this is not yet priced is the fact that there is still a really strong dialogue around corporate margins and a big fear that margins will pull back from what have been levels--
Because they've been elevated.
Because they've been elevated. They've climbed. But I actually think that because of this adoption of AI, corporate margins could be more resilient across the board. But that healthy debate is part of what tells me that this part, this third leg, is not yet priced.
I've observed over the last several years that shareholders have been very tolerant of management companies deploying capital into artificial intelligence. Do you think that in 2026, we will see more shareholder demand for descriptions of what the return on those investments have been?
I think no doubt. I mean, look, the large-cap technology companies, their business model is shifting. They're moving from capital light to capital intensive. And companies across the board, I think, are in this phase now where there is real FOMO, Fear of Missing Out, because you don't want to be the number two, number three, number four. You do want that first-mover advantage.
But I think coming with that, there obviously will be accountability for technology players but players across the board, because otherwise, that capital could have gone to share buybacks or dividend growth i.e. shareholder returns.
But for now, for this part of the J-curve, it makes sense to invest. And I think they would be the first three pillars. The fourth would be in private markets. Private markets, we know that companies are staying private for much longer. And that is particularly the case in the technology sector.
So now you're seeing an average tech company would stay private for 14 years. That used to be eight years. And when you look at the 10 largest players in private markets technology, they're worth $1.5 trillion. So there's a huge amount of opportunity there.
There's also risk because there's a lot of cash, dry powder, flying around. So as always in private markets, you do need to be selective. But I would definitely have an inclusion of private when it comes to accessing AI.
So let's broaden the conversation out a little bit beyond just specific to artificial intelligence but the impact that it might be having on equities around the world. So when you think about equity returns in 2026, we've already mentioned potential double-digit returns, the potential for double-digit earnings growth. How much of this is attributed to this megatrend of artificial intelligence?
A decent amount. I've mentioned 20% earnings growth, we think, out of the US large-cap tech players for the year ahead. But I think there is this broadening theme with some of these other sectors. I mean, there's five sectors of the S&P that we like. I've mentioned some of them in technology, utilities, and industrials, but also financials and parts of the health care market.
And so all together, I think that you could be moving from a period driven primarily by tech, where S&P earnings that historically have been around 7% per annum could be more like high single-digit to low double-digit returns, which would be a new era of growth for the equity market and, most importantly, would compensate for some of the valuation.
Said differently, you could still see equity market valuations fall and equities rise 7% to 10% per annum because of the underlying earnings dynamics. So our price target for the S&P specifically over the next 12 months is 7,300. That's just shy of a double-digit return. And it's a similar return around the world actually in the developed market. So yeah, positive outcome.
It's important that we point out how unique that is. This would be the fourth year of double-digit growth for the equity markets, which is certainly something that we don't see very often now. If we are right in that expectation of continued economic activity, which is positive around trend growth, we get positive equity market returns as well, does that bode well for the credit markets?
It does. I mean, many of the dynamics are the same. And broadly, we are talking about large-cap equities here because of the strong underlying balance sheet that they have. But I think all of this, whether it be an equity or credit markets, we're constructive there. We think that the yields are attractive. But all of this is indicative of the fact that I think you are seeing increasingly economic value flow to capital rather than labor, which is good ultimately for owners of risk assets.
Excellent. All right. So, I sense your optimism for the capital markets as well as the economy. Our title of our outlook this year is promise and pressure. I suppose it is this optimism that is the promise component.
Now let's spend a second on the pressure, namely the idea of global fragmentation.
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Text, 2. Think Fragmentation, Not Globalization.
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I'd be curious to hear what is it that you mean when you talk about fragmentation. Is this just a continuation of some of the trends that we've seen in previous years, or is this something different altogether?
No, I think there's a real sense of change that's coming about at the moment with countries really looking inward. And this really means that they are prioritizing self-sufficiency, security. And there are many issues around national security that I think are in focus, from trade to immigration to energy security, supply chain, and critical components and minerals as well.
And whilst there's certainly been catalysts that have played out through 2025, I don't think it is a brand new theme. I think, actually, you can go back to my previous comment about how increasingly you've seen economic benefit flow to labor-- to capital rather than labor, which has caused some disenfranchisement amongst voting populations that we've seen play out over a number of years. Of course, the COVID pandemic caused supply chain vulnerabilities to come to the fore.
So, security overall is another huge theme for us along with artificial intelligence. And it's not just, again, a US theme from 2025. This is undoubtedly global because the theme of economic nationalism is also prompting a strong fiscal response.
And so when you look to areas like Germany, very strong government direction of capital with the infrastructure bill and defense spending. And this, I think, is going to see, as an example, German GDP be pretty close to US GDP by the time you get to 2027.
That is remarkable. And it does feel like it is permeating beyond just national area but also at the corporate level. JP Morgan, for example, has just launched our trillion and a half dollar security and resiliency investment plan. And so you're seeing it take place in multiple levels. Now, what does that mean from an investment opportunity when you think about security and the investment in security around the world?
I think there's two things. The first thing is the spread of growth. So as governments are playing a firmer hand in the economy and corporates can obviously follow suit and potentially benefit from that, you're seeing growth being spread more evenly around the world. And the example I'd give was, as an example, US and Germany.
The second thing is, again, when you think about the investment opportunities, this speaks to industrials, infrastructure, and real assets. So again, you're seeking out, from fragmentation opportunities, new opportunities of growth where the value, the economic value, is going to accrue to the shareholder. So--
Now, we've seen some of this fragmentation already play out. And when you think about the year that is ending now, this is a year characterized by the flight from the dollar. You've seen the dollar decline. There was concerns about treasuries. And so when you think about what is taking place today, is that a trend that you think will continue as well in terms of dollar decline?
Yes. I mean, the dollar really has been the vehicle through which the market has priced a lot of this fragmentation risk, and even deeper than that, concerns over deficits, over trust in the institution. And that obviously is what's led to what, for many of our euro and sterling-based investors, has been quite a painful leg down in the dollar through the course of this year.
Obviously, elements of that are going to continue. I think that the big overvaluation of the dollar has already played out. The worst is behind us. There could be, over the medium term, still a drip lower in the dollar.
But I think if we look to just 2026 and the cyclical backdrop that we see-- and you alluded to this clay in your walk-up to some extent-- we've got growth that we think in the US is actually going to re-accelerate in the first half of the year. You've got inflation that could stay warm and a Fed that whilst it's cutting, may not cut quite as much as the market thinks that would support interest rate differentials in the favor of the US.
So our thought is more cyclically that the dollar is going to be in a period of consolidation now. But the longer-term themes that we're talking about in this chapter of the outlook, I think, still are in play and still does very much prompt, say, a flight to gold, where I still think there's more upside and, indeed, the diversification angle.
I want to hear more about gold. But let's wait for a moment. The last several years, as the world globalized and as the supply chains became more linear, you saw many market participants simply invested in the United States because you could benefit from growth taking place all around the world by investing in the United States.
Do you think that next year, we will have to be more diversified internationally because of some of this inward move that you've described? To participate in the growth in Germany, will you have to make investments locally? Or do you think you could still do that via supranationals?
I think that the multinationals in each region, I think, are still a really sound place to go because typically, they have the quality balance sheets that we seek and that we spoke about before. But I do think that it's going to be a really sound philosophy to be far more intentional about how you diversify.
A lot of this, again, speaks to clients that have got different funding needs, different currency needs, that I think that the geographic diversification piece is going to be even more important. And we've mentioned Europe a few times. But there are equally very sound opportunities when we look to emerging markets that are emerging from a decade of underperformance.
And even in areas like China, when we think about how their economy is changing, China is going to see more revenues out of technology than it is out of property and construction combined. So some really quite fundamental changes that are arising from governments directing capital and economies responding.
Excellent. So this idea of fragmentation, should it continue, is likely something that will compel us to think differently about the way that we construct portfolios in 2026 and beyond.
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Text, 3. Prepare for Inflation’s Structural Shift.
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Let's talk a moment about inflation, the third of our megatrends. This is also something that might compel us to think differently about the way that we construct portfolios. Steve, it was only a couple of years ago that you couldn't find inflation anywhere throughout the developed world. Now, postpandemic, that experience has been a little different. Talk to us about that evolution of inflation and why it is the concern that it represents in portfolios today.
Yeah, I think a lot of the trends that we've been talking about, whether it's increasing fragmentation, greater fiscal spending, some of these imbalances in markets, the reversal of the globalization trends that was all about efficiency, mean that we're probably in an environment where the floor on inflation is higher and the volatility of inflation is going to be greater.
Now, that has a meaningful impact in the way that we think about portfolios. Because traditionally, in a world where inflation wasn't a concern, a traditional stock-bond portfolio could do a lot of the heavy lifting. You could allocate to stocks for growth. You could allocate to bonds for income and diversification.
But as we've seen over the last couple of years, in a world where inflation becomes a bigger risk, then perhaps bonds aren't going to be able to play that same role in diversifying your portfolio.
Now, talk to me about the level of inflation. So in this moment postpandemic, it reached almost 8%. This was while a lot of market participants thought that inflation would only be transitory. And it has proven to be anything but. Right now, current level of inflation, and what is the expectation for 2026?
Yeah, we think inflation is going to move from-- right now it's in that 2 and 1/2% to 3% range. We think it gradually begins to come down. Our view for 2026 is 2 and 1/4% to 2 and 1/2% here in the US, probably a little bit higher in the front end of the year, a little bit lower in the back half of the year as some of the tariff impacts begin to wane.
Now, one of the things to remember, we often think about inflation. And we think about the risks associated with inflation. Inflation, if it's stable, if it's not too high, is actually a good thing. It contributes to pricing power. It contributes to nominal economic growth, and it contributes to earnings.
And so when you think about that 2 and 1/4% to 2 and 1/2% range we're looking for next year, it's a sweet spot because it supports that growth. But it also gives the Fed cover to continue easing. And we think we're going to see two more cuts in the next year.
So many have characterized inflation as the great confiscation of wealth. As you point out, that's not necessarily the case. But just the same, as you think about building portfolios in 2026, as you think about opportunities which might protect you from some of the impacts of rising prices, where do you begin the conversation?
Yeah, if inflation is the bigger concern, then we think you need to change the playbook a little bit in the way you think about diversifying your portfolio. Specifically, you want to look to things like real assets, gold, and infrastructure as potential ways to hedge against some of those inflation risks.
And importantly, these conversations that we're having now are not just tactical views about the next 6 to 12 months, but rather more strategic conversations in a world where we think inflation will be structurally higher.
Grace, we'd like to talk about other alternatives within the portfolio. You've spent a lot of time talking about gold. You've mentioned it a couple of times in this call as well. Do you think that will continue to represent an important part of it?
I do, Clay. I mean, it's hard to believe, isn't it? After a 50% rally this year that followed already an up year in the prior year, we're looking for another 30% on gold. So that'll take us to around $5,200.
And why is that? Feeding into a lot of the things that Steve said, what's missing from the portfolio if you just have the stock-bond starting point, which is a great starting point but, I think, can be enhanced.
We are looking to lean into uncorrelated returns, or at least less correlated returns, and hedges for many of the issues we've discussed for elevated deficits, for mistrust in the institution, including the Federal Reserve.
And I think gold really satisfies that request, not just for many of our clients, but actually for many of the central banks and significant institutional allocators of capital. So we've seen some of that play out already. That's obviously what's driven the gold price higher. And the supply of gold is so tight that small changes in demand can drive it quite meaningfully.
But consider that when we look around all of the EM central banks, 16 of them still have below a 10% holding in gold. China is now up to 9%. And that compares and contrasts with a European central bank. That would be at 15% to 20%. So whether it be central banks, institutions, or of private clients via an ETF, I think gold can still move considerably higher.
That's interesting because this is not out of concern that you're describing this rally. This feels almost more structural and independent of some of the market moves.
Yes, I think that's absolutely right. And it's a natural way to think. Whilst I like the US equity and economic story, if there's a lot of dollars already in a portfolio, what's a natural thing to bring in to increase diversification? It's gold.
But it doesn't stop there. I think there's other things. We've mentioned infrastructure as well. But I'd also consider hedge funds, and specifically macro and relative value hedge funds. And I think, again, this is a great sort of simple step to enhance the overall portfolio volatility and correlation benefits.
So whether you call them alternative investments, nontraditional investments, it feels like this is the area in which we're looking to expand the toolkit within a portfolio, perhaps real assets, commodities, noncorrelated hedge funds, infrastructure investments. It certainly is a bit of a change in the way that one would build a core and diversified portfolio.
So with that, let's wrap. We expect a year of promise and pressure in 2026, one characterized by positive economic growth, higher equity markets, lower interest rates, and perhaps higher in volatile inflation.
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